| Characteristics of Accounting |
| Net profit reported in the income statement is one of the key measurements of a company. It tells the reader how much income the company has made after the expenses they had to pay. The formula for net profit is: Revenues – Expenses = Net Profit We may have several different types of expenses which will be listed out by category. The income statement like other financial statements will need to follow GAAP in order to be considered accurate. International Financial Reporting Standards, or IFRS, are used by international companies and are less detailed than GAAP. Characteristics of Accounting Information In order for accounting information to be useful, it must be relevant, reliable, comparable, and consistent. It should be useful for evaluating and predicting the future.
Assumptions Underlying Financial Reporting
Principles Underlying Financial Statements
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| Elements of the Financial Statements |
The list is as follows:
An understanding of the accounting equation is one of the most important areas to grasp at this point since future weeks will continue to build on this understanding. To understand the equation itself, you first need to understand the different categories and what goes into them: |
| The Accounting Cycle |
| A company’s accounting system is kept in the general ledger. A general ledger is a record of each account and the transactions that affected the balance during the year. We have specific steps of handling accounting transactions in order to get them to the ledger. The journal is the location where we store each individual transaction. The journal is recorded in chronological order and we will end up transferring out the transactions to their individual ledger account. This transfer process is referred to as posting which is the posting from the journal into the individual accounts. This is much like a personal checkbook in that you keep a record of your deposits and payments chronologically but in order to know how much you spent in a specific area, you would need to transfer those amounts out into individual account ledgers. Here is the list of the complete accounting cycle which we will discuss next:
Now, let’s begin a discussion on the different steps:
As previously mentioned, assets and expenses are increased with a debit and decreased with a credit. Liabilities and owners’ equity are increased with a credit and decreased with a debit. Students often struggle when they first are learning journal entries in trying to remember how to treat everything. Here is a helpful hint that will help you learn how to handle the cash account which is very often involved in the transaction. |
| Debits and Credits |
| When we spend money, we write a “C” check. “C” in check is like “C” in credit. So, when you review a transaction involving cash, if we got some, you would think of this hint and remember that we deposit cash and that must be a debit to cash. If we are paying out money, you would associate this with writing a check and credit the account. If you have a good understanding of ½ of the transaction, it will be easier to remember if you debit or credit the other account. All other assets are handled like cash. When we get some, we debit them, when we get rid of some, we credit the account. Liabilities and stockholders’ equity are on the opposite side as the assets so they are handled the opposite way. |
| Journal Entries |
Let’s walk through each journal entry that needs to be prepared:
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| Posting Journal Entries to the General Ledger |
| As you approach the concept of journal entries, remember that practice will help so take advantage of your reading examples and also these examples. The more you do these, the higher your understanding levels will reach. Accounting Cycle #2 (Post the journal entries to the general ledger): As noted above, the general ledger is a set of individual accounts. We can use t accounts to simplify the general ledger group and will follow the same rules of the left side being the debit and right side being the credit. So, if we had $20,000 that we received from an investor and our transaction was a debit to cash for $20,000 and a credit to common stock for $20,000, we would record this in the cash and common stock accounts as follows: (These are T accounts—Left side is debit and right side is credit.)
Every cash transaction we then have will either be a debit or credit to this account and likewise with other accounts. So, if we borrow $10,000 from the bank in a long term note, we will debit the cash account for $10,000 which will now give us a balance of $30,000 if that was all we had for the period. We would also have a new account for the notes payable we would enter the $10,000 into. |
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| Preparing an Unadjusted Trial Balance | |||||||||||||||
| Accounting Cycle #3 (Prepare an unadjusted trial balance): Once we have all of the balances in each individual ledger account, we are ready to prepare an unadjusted trial balance. This is a report showing all debit and credit balances and each account and is used to verify that the debits equal the credits and also to give us a chance to review any accounts that might need to be adjusted. Here is a sample unadjusted trial balance: Account Debit Credit Cash $100 Accounts Receivable $300 Inventory $900 Common Stock $800 Accounts Payable $ 200 Sales $3,000 Rent Expense $400 Office Supplies Expense $700 TOTALS $3,200 $3,200 If the totals do not balance, you will need to go back and review each journal entry to make sure that it balances and then check your transfer from the journal to the ledger to make sure you put the amounts in the correct column. Finally, if you still can’t locate this, re add up each individual ledger account to double check your balances there. Accounting Cycle #4 (Prepare adjusting entries and post them to the general ledger): Under the accrual method, there will be items that need to be adjusted at the end of the period in order to bring certain accounts to their correct balances. We have briefly mentioned a couple of examples of this in the revenue and expense section related to the unearned revenue account and prepaid expense account. Here is an overall summary of the different categories of adjusting entries:
Example: |
| Preparing Adjusting Entries |
Example: no entry has been done:
Example: no entry has been done:
Example: no entry has been done: |
| Preparing Adjusting Entries Example |
| Next, let’s look at the second adjusting entry. We have wages that have not been recognized. Think about what the journal entry would look like and see below to confirm that you are correct. So, here is what the complete solution looks like along with the ending balances in each column which are calculated:
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| Preparing the Adjusted Trial Balance and Financial Statements |
| Accounting Cycle #5 (Prepare the adjusted trial balance.): This is the same process as step #3 in that you prepare another trial balance but this time, you will have the new balances after the adjusting entries have been done. Again, you will want to make sure that the debits and credits balance and that all accounts look reasonable. Accounting Cycle #6 (Prepare the financial statements.): Using the adjusted trial balance, you are now ready to prepare the financial statements. Here are the 4 financial statements that need to be prepared and the order:
Accounting Cycle #7 (Close the temporary accounts.): |
| Closing Process Example |
| The closing process includes 2 different journal entries. The first entry is the closing of the revenue account into retained earnings. Since the revenue account normally has a credit balance, we will need to debit that account for the balance to create a $0 balance and offset it against retained earnings so the journal entry will look like this: Debit revenue accounts $X Credit retained earnings $X The second entry is the closing of the expense accounts into retained earnings. Since the expense accounts normally have a debit balance, we will need to credit these accounts for the balance to create a $0 balance and offset it against retained earnings so the journal entry will look something like this: Debit retained earnings $X Credit cost of goods sold $X Credit expense account #1 $X Credit expense account #2 $X Credit expense account #3, and so on $X |
| The Final Step in the Accounting Cycle |
| Accounting Cycle #8 (Prepare a post closing trial balance.): Preparing the post closing trial balance allows for a check of the accounts still in the general ledger to make sure no temporary accounts remain, and that the accounting equation is still in balance. This is another trial balance but now will have the latest balances after the closing of the accounts. Now that we have looked at the different examples under the accrual basis, you should have gained a better understanding of the different time periods that we recognize revenues and expenses in, because there can be a big difference if it is not done correctly on the financial statements. We have now been through the complete accounting cycle so you can see what happens from the beginning steps throughout the period to the closing process. As you have seen, there are many transactions that involve the cash account which makes internal controls especially important in this area. The company will analyze the risks associated with cash and collections and put controls to minimize risk. Cash is a temptation for theft due to the nature of its use. Therefore, as a company we need to work to have a strong safeguarding of cash and other controls put into place such as bank reconciliations. Bank Reconciliation A bank reconciliation is a comparison between the records of the bank and the records in the books and adjusting for any discrepancies. Due to the timing of transactions and other things that we might not know about in our books, the bank statement balance and the book balance will most likely not match. We need to prepare a bank reconciliation making adjustments to each applicable side. It is a critical part of controlling cash. Here is a template that is often used to prepare this:
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Attachments:
Accounting Re….docx